Market Set To Rally

The economy’s lousy, corporate earnings are terrible, and the most aggressive rate cuts by the Federal Reserve since 1929-1930 have failed to help.

Looks like it’s time to buy stocks.

At least that’s what investors plan to do this morning, with the index futures all above fair value, and in the short-term, they’re probably right. This market has taken about all the shots we could imagine and is still standing. There’s an old saying among traders: That which does not go up eventually goes down. In a bear market, the opposite may very well be the case: that which does not go down eventually goes up.

But a big cautionary note is in order: bullish sentiment is at very dangerous levels here. The Investors Intelligence survey of newsletter writers reportedly came in yesterday with one of its giddiest readings of the last decade. That kind of sentiment – bullish by more than 2-to-1 – normally occurs at market tops, yet bullish sentiment has actually grown throughout this two-month correction, which means the correction has done nothing to work off excessively bullish sentiment. And the commercial traders – the so-called smart money – remain bearish on this market, still short the big index futures. A market move that begins with giddiness and the lack of participation from the smart money does not seem like a promising place to put long-term money to work. Stranger things have happened, but not by much.

On the other hand, the one thing about the rally off the April lows that has had Elliott wavers scratching their heads is the lack of a “C” wave, or second leg up, that even a bear market rally should have (see chart below). A strong rally with these sentiment readings could produce that “C” rally.

The good news, if it can be called that, is that the U.S. dollar finally tanked yesterday. This is good news for all the companies that have been claiming that currency translation issues have been hurting profits (the latest was IBM last night). A weaker dollar could also help the CRB commodity price index, which rolled over hard this week after a promising breakout last week, and remains in deflationary mode. The weaker dollar was likely a reaction to Fed Chairman Alan Greenspan’s suggestion yesterday that more rate cuts are probably in order.

Nokia’s better-than-expected earnings (after warning last month) and prediction of a fourth-quarter rebound is also helping sentiment this morning, as is Dell’s reaffirmation of its guidance (which could also be interpreted as a revenue warning). But yesterday’s action in the major indexes formed a bearish candlestick of questionable reliability called a hanging man; a negative close today could confirm that pattern. And the indexes are beginning this rally from overbought levels, which could limit upside to a couple of strong up days.

Perhaps, as Greenspan said in his surprisingly negative testimony yesterday, there are “signs that the bottom is beginning to structure itself.” If the economy can overcome near-record debt and overinvestment, falling personal wealth and a rapid slowdown that has been among the steepest in the postwar economy, then the Fed chairman deserves his reputation.

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